There is a fundamental misunderstanding about the Wall Street bailouts amongst the public, and quite a few policy makers at Treasury and the Federal Reserve: Somehow, they “fixed” the banking system. All it took was few trillion dollars in liquidity and a few $100 billion dollars in recapitalization, and all is now fine (I suspect some people at the Fed know the Truth).

In fact, they did nothing of the sort. The banking system was not saved; The massive injection of liquidity temporarily salved the day-to-day operations of banks, but they did not repair what ailed our financial institutions. Indeed, pouring billions into nearly identical management teams that mismanaged the risk, over-leveraged exposure, and drove banks off the cliff in the first place was an invitation for another crisis.

And that crisis now appears to be arriving. And, its our own fault.

Consider what was actually done in 2008-09, and you will understand why none of the underlying problems have been repaired:

• Bank holdings: Remain stuffed with declining assets, primarily in Housing and Derivative holdings. Another leg down in Housing could be nearly fatal.

• Capitalization: Remains too thin; leverage should be mandated back to the pre-2005 rule change of no more than 12 to 1; As we have learned, management does not keep adequate capital unless mandated to do so (sufficient capital reserves cuts into profits);

• Misaligned Incentives: Compensation and bonus schemes were not significantly changed after bailouts, except during loan repayments. Thus, management and traders still have the same upside to roll the dice, but do not have the downside risks, which remains on shareholders and taxpayers;

Let’s use a counter-factual, a simple thought experiment of what would have been had we gone Swedish on banks like Citi and B of A, placing them into a prepackaged reorganization (that’s a polite phrase for “bankruptcy”).

The easy stuff: Senior management all gets fired. More than just the CEO — nearly the entire top floor at the bank, including the Board of Directors, gets canned. Equity shareholders get wiped out. Whatever is left over after all is said and done goes to the bondholders, typically, at about 25-50 cents on the dollar. (Note that in Sweden, bondholders got 100 cents on the Kroner, but that currency was significantly devalued — so the bondholders were not made whole, they lost between 50-75%).

Temporary nationalization is the play: Uncle Sam provides debtor-in-possession financing to keep operating. All of the bad holdings, mortgages, derivatives and other liabilities are pulled out, and auctioned off. This includes the REOs, the CDS/CDO book, defaulted mortgage obligations. Remember, there is no such thing as toxic assets, only toxic prices. At some valuation, these are worthwhile investments — just not 100 cents on the dollar. Let healthy buyers pay 15-30 cents.And anything that is worthless is written down to zero.

We recapitalize the parent bank, and spin off each division: IPO Merrill Lynch for $20 billion, spin out a clean Countrywide at $8 billion, sell of all of the non depository bank pieces. What you have left over is a well capitalized bank, owned by Taxpayers, with well capitalized former divisions as stand-alone companies. All of the above have transparent balance sheets (No FASB 157 required to hide the garbage investments). Eventually, everything is spun out back to the public markets. Uncle Sam is repaid, and what is left over goes to the bondholders.

This would have created a transparent, unleveraged, adequately capitalized banking system that would be contributing to, rather than detracting from, the US economy.

But all that was a missed opportunity — for W and O alike. What we have today instead is an over concentrated set of banking behemoths, barely off life support. Many of these remain mortally wounded by the holdings — holdings that they would have to shed through a healthy reorg.

The recent downturn in the banking sector? I suspect it amounts to nothing more than a credible bet that these banks are not in any condition to withstand the next recession. (No, it was not Henry Blodget’s Fault). A rise in unemployment and another next leg down in Housing could very well be fatal.

If the banks come crawling back to Uncle Sam for another bailout, it will be proof that “rescuing” failing financial institutions that blow themselves up is the exact wrong strategy.

Real Capitalists know failure is part of the process. I suspect we may have another chance at a banking reorg. Let’s hope we do it correctly this time . . .

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

65 Responses to “Big Banks: Under-Capitalized, Overexposed, Opaque”

“And the banks — hard to believe in a time when we’re facing a banking crisis that many of the banks created — are still the most powerful lobby on Capitol Hill. And they frankly own the place,” Senator Durbin, 2009.

Well we’ve been struggling with this problem since the 80′s in one form or another.

The central problem is a very large chasm in viewpoints between two completely different worlds.

You have the economic models of the Boomers … Coca Cola, Buffett, Picnics at the park near your closest Levittown, a F150 and a load of mulch in every driveway….. And Gen- X and Gen-Y.

Video Games, Heavy Metal and Punk. Fly by the seat of the pants. Where’s the next wave? Take “nothing” seriously including Uncle Sam and his precocious greenback.

It’s the same ole story. Old men with old capital trying to prove to the rest of the world that they STILL are the King of this Thar Hill.

When to be completely honest, people were laughing at the Reagan masks over a decade ago.

There’s really no problem to be fixed. It’s just another wave of America.

Now don’t get me wrong, if you’re broke and indebted to one of these behemoths and are landlocked feeding your kids through your local gig as a gravedigger, you’re obviously going to have a completely different viewpoint from someone free to pursue his or her own path in the land of the red white and blue.

But come on, we have those people all the time. It’s like florists. You’ll find one on every main street. It’s just all of the gosh darn sudden we’re overly concerned about the plight of the florist. The Internet is to blame, plain and simple, because as I’ve said it gives people the impression they can reduce large “macro” economic forces which are the result of millions of people pursuing their own self interest into some personal application to their lives.

Why should I pay my electric bill? Lloyd Blankfein owns a nice boat. The two are completely unrelated.

Maybe a day of national catharsis. We can have a bunch of hippie progeny burn Trump, Jamie, Lloyd and whatever else is the flavor of the month in effigy, and then run around like a group of Libyans who just freed Tripoli. To be honest, I can’t believe there’s still this push for a witch hunt. There is no sacrificial lamb. Get on the board, howlie. The next wave is coming over the horizon.

Oh and I have a big mouth and an even bigger pen and both write and speak too much :->

The 2001 Nobel Prize in Economics went to Akerlof, Spence, and Stiglitz for….wait for it….ASYMMETRIC INFORMATION.

So we have some of the most powerful “capitalists” in the world hiding behind asymmetric information for fear of what would happen in a truly competitive market (the kind they defend in public but not private — who can forget the public statement that GS was doing “God’s work”). The gov’t supports them as it continues to fear TBTF and cannot accept that failures are a defining part of competitive markets and capitalism.

Having just finished “Bailout Nation” this morning, these recommendations are from the last chapter. They are still good recommendations. Why the government and the Fed thought that just papering over the long term problems with “extend and pretend” was going to work, is mystifying.

As long as we are going to fire top management and the boards at these failing banks, how about we go ahead and fire the management of the Fed, SEC, FDIC, etc and start all over there, too.

“Let’s use a counter-factual, a simple thought experiment of what would have been had we gone Swedish on banks like Citi and B of A, placing them into a prepackaged reorganization (that’s a polite phrase for “bankruptcy”).”

Excellent post and no doubt would have resulted in a much better outcome – but the word “nationalization” is demonized by the Right and would never fly – but you know that. Current political rancor makes it hard to envision a practical workable solution that could actually pass.

FASB 157 allowed them to hide a lot of junk in the trunk, there are still enormous RE chickens that need to come home to roost.

BAC has been dropping very broad hints that QEIII is required to avoid financial armageddon, I’m sure this alarm is very self serving. Somehow the TBTF with Fed assistance need to dump their bad RE loans onto US taxpayers and BAC comments sound like they need this help pronto, NY AG Schneider is squeezing them, BAC needs blanket immunity for all their illegal mortgage activity and Schneiderman isn’t being a team player by insisting on justice.

Barry….there must be a few less sick, survivable banks in the sector. What big banks are the healthiest in the sector? Who has done the best in adapting to the “new normal” for banks? For example Wells Fargo…

It seems the faulty derivatives clogging the balance sheets are really no more than counterfeiting, with the ratings agencies paid-off to stamp them as “good-money”.

TARP would never had been passed if Congress had been told the truth – that the banks were insolvent. Since that fact was privately communicated in March 2008 by Mervyn King, that left 7 months to build a plan to restructure the system.

For some reason, that did not happen, and the future health of the country was sacrificed for – what?

Amen to what has been said and here is one more bizarre example of bank behavior. My daughter put in a bid on a short listed condo almost three months ago and is still waiting for the bank to appoint a negotiator to finalize this deal. She’s been preapproved for a mortgage, has 20% down in the bank and is ready to move. The owners accepted her offer within the first week (I think this is a state requirement) but the bank has done squat. Last week she hears that the bank is reassessing the asking price (that they themselves listed!) in light of changed market conditions (what has changed??? maybe lower interest rates?). Here is a classic example of how a bank had (and still has) a great opportunity to get one property off their books and what do the do? Not much. I’m pretty disgusted by all this.

[...] Big Banks: Under-Capitalized, Overexposed, Opaque | The Big Picture The US banking sector is not healthy. There is a fundamental misunderstanding about the Wall Street bailouts amongst the public, and quite a few policy makers at Treasury and the Federal Reserve: Somehow, they “fixed” the banking system. All it took was few trillion dollars in liquidity and a few $100 billion dollars in recapitalization, and all is now fine (I suspect some people at the Fed know the Truth). (tags: banks capital regulation) [...]

With respect to returning to the pre-2005 leverage limit of 12:1, to put things in perspective, what are the current ratios for the larger banks and how do they compare to pre-crisis? Does anyone know of a reliable resource to find this data? Thank you.

If you cannot spell a word properly–”howlie”?!?!?!–you probably shouldn’t be using it in an attempt to seem “hip.”

And I think you have some major differences between gens x and y which you have elided in your post –and you certainly have some big ones between all of the above and the so-called “millenials”–when it comes to attitudes toward money, government, power, success, etc.

But mostly Haole, you need to remember to spell that word right and of course, LEAVE LOCAL GIRLS ALONE!

You keep banging this same drum. It’s a great solution but it’s simply is not going to happen. The political will is simply not there. Do you see any alternative options for healing/fixing the banking sector?

Barry’s point is amply supported by the banks acting as if tightened lending standards are the coup de grace. They got nothin’ in the way of a viable alternate business model. With banks returning to the pre-bubble 20%-down standard, loan revenues (and more importantly, sales of loans on the secondary market) are way down and project to be down indefinitely.

I watched sections of a March 2011 C-SPAN interview with Kathryn Wylde and noted her pitch that Dodd-Frank is hurting middle-income New Yorkers by creating “uncertainty” among banks causing them to require 20% down. Ordinary New Yorkers don’t have $100,000 in cash lying around to buy a triple-decker with near-guaranteed rental income! she was saying. Oh, the unfairness of it all. Because, you know, she’s just trying to represent the best interests of the general public.

As if ordinary Americans can’t invest in income property with partners (i.e., friends, family) to buy a triple-decker. Especially cityfolk. And especially the more organized immigrant communities of cityfolk, like the Vietnamese here in Boston. Sure, a middle-income nuclear family probably doesn’t have $100k lying around, but whatever. Successful people work with others to get ahead.

But what Wylde’s anti-regulatory stance really highlights is how any scrutiny at all results in reduced revenue for the banks — based on the disastrously failed business model that still hasn’t been pried from their cold, dead hands. So they’re pinched by the oh-so-onerous capital requirements, opacity (i.e., show me the risk load you’re carrying!), lending disclosures and reverting back to 20% down. Cry me a river.

Wasn’t it NAR that just the other day said we need to seriously reconsider relaxing lending standards again to clear out the foreclosure backlog? Same deal.

There seems to be considerable debate about whether or not another US banking crisis is about to arrive, and not just among the policy makers. For example, Doug Kass recently recommended investing in the XLF claming that the US banks are actually much better off than is currently believed. He predicted a doubling of that index in the next 12 months.

I always get uncomfortable when two people that I generally trust appear to be saying the polar opposite of each other. Any ideas on how to square that circle?

BTW, I’m not disagreeing with BR’s general point that the US “solution” to the 2008 financial crisis was less than ideal and that, due to the lack of structural reform, we are likely to see another major problem some time in the future. I’m just questioning the statement that we are currently on the verge of another crisis.

No love for the bankers, to be sure, BR, but I recall the argument of a few years ago (sorry I can’t source it) that the regulators were not up to managing the banks, esp. the likes of Citi, with over a thousand subsids worldwide. Any insight as to how a re-org would work if we canned the “top floors?”

I like to use the metaphor of the San Andreas fault for out banking system. Everyone knows at some point the stress levels on that fault will become just too great and it will fail. It’s anybodies guess just how devastating and damaging that eventwill be. At some point the stress on our banking system and the TBTF’s will become just too great and it to will fail. It’s anybodies guess just how devastating and damaging that event could be.

heres to the real capitalists its a real short list
these days they only wave the no regulation flag
even with light touch regulation like narrow banking , good accounting, where are they on the rating agencies?
and the wall st losers salivating over grandmaster B giving them another injection friday should be ashamed of themselves

but i bought a little JPM and BMO last week
tho i wonder about the first

sheep from the goats
if idid anything w XLF i be short or long the good against xlf?
prob is in inital stages of short covering rally the complete garbage,
stuff on my short list
goes up most for a day or two

All great ideas, Barry, and would love to see them implemented; but your post seems to ginore the wholesale regulatory capture that currently exists in the capital and the SEC. The big banks are regulated only to the extent that they allow themselves to be.

Sorry meant to say ‘ignore’. When it is deemed that corporations are given the same status and protections as individuals WRT campaign contributions, we can’t say we’re heading i a positive direction. We’ve only ensured that the downslope of failed oversight will only get steeper.

BR,
I have been reading your blog for a couple years, and I think you are being a little naive with your position that the US should have adopted the Swedish model for banks. The scenario you describe is one potential outcome, but given the uncertainty in the marketplace it would have been very risky IMO.

First, the market structure is extremely complex, for the US Government to come in and wipe out all of shareholder equity and force bond holder to take a haircut is absurd. Best outcome, the Government comes in and bond holders and stocks holders file lawsuits and the whole process gets thrown into the legal limbo. Given the structure of the US Gov, there is no mechanism to do what you are suggesting.

Second, you totally overestimate the capacity of the US Government, who would be tasked to do this? The Treasury department? Most likely, the US would have to outsource this role to a financial firm to do, which would create all kinds of conflicts. Remember, the US Government could not even manage to buy the bad debt from banks and auction that off, TARP turned into a direct investment by Treasury.

Third, where will the money come to pay the FDIC insurance? You think they have to money to cover all the deposits?

Fourth, even if the US Government could pull off what you describe, there are a whole bunch of potential negative outcomes you forget to mention:

-What about the money markets, so a bunch of money markets will surely break the buck, which will destroy investor confidence leading to major risk aversion, the stock market could have easily fallen another 30-40% had the money markets broke the buck.

-If the markets collapse, GDP will surely contract, which will make the debt burden even greater as debt to gdp would go up. This would restrict the US ability to borrow and could lead to Government default

-Of course the States would then see a collapse in revenues and they would potentially default, creating a vicious feedback loop

-Debt is ingrained in every aspect of our society from accounts receivable to credit card payments to three day settlements for equity trades, this whole system could have potentially fallen apart.

So stocks collapse, US investors lose most of their savings, pension funds collapse, US Gov debt falls, who is left to buy? Sovereign Wealth Funds and newly capitalized buy out firms will just stand aside and pick up the pieces from the fallout, the truth is Wall Street would have benefited immensely from a collapse, they would have just got new capital and picked at the bones. The real bailout was for the political system and Main street.

The solution is you don’t put yourself in that position in the first place.

one unexposed facet of this giant financial sector turd
and its recurring crises
is the latest crisis of the mortgage insurer and pool insurer group
which at one point i noted insure 2.4trillion is that right?
PMI has in effect just gone broke last week trades for 17 cents
the others stocks have fallen 0ftern 80%
Radian RDN MTG have fallen from $8 or more to $2 or less
i tried to short MTG but unfortunately stopped out too early
while a lot of their insurance is fannie freddie they cover the waterfront
and much o f the stuff that BAC etc may show as collateralized or no capital needed
is collateraized w this fake insurance

“The big banks are regulated only to the extent that they allow themselves to be.”

I pretty much agree. And that’s why I doubt more regulation is the answer. How do we get these banks to break themselves up? Maybe by lessening some of the regulation so the smaller, more nimble banks can compete more effectively with them?

I would love to know why Obama didn’t “go Swedish” on the banks, why he didn’t follow Volcker’s advice to break up too big to fail.

What was the counter-argument he was hearing? What were Geithner and Summers telling him?

Or was it a political decision? Remember back then all the clamor from Fox News and the GOP was about how Obama was a socialist and was taking over major sectors of the economy. Did that make him afraid to nationalize the failed banks?

I agree with the comments that question whether it was possible in this political environment. CNBC is all about covering “Obamas war on wallstreet”..Scaraduchi “we feel like a pinata”..Cohen “unafraid in greenwich”.

Fox takes it even farther..”govt takeover..socialism”

Most congressmen are bought a paid for the same entities. The media are filled w/ WS advertising and PR flacks..

If BR is talking again about bank insolvencies, Phase II of the Great Implosion is underway. Housing is still tanking. Unemployment is creeping higher. Nothing constructive was done with the Fed’s papering over of the structural problems, except that now the private losses have been publicly assumed. It is now the Federal government that teeters on insolvency (just another $1.3 trillion added to the federal debt in this fiscal year, according to the CBO, based on its somewhat rosy assumptions). Who will reorganize and restructure the Federal government such that it survives in its present configuration? Exactly. There is no one and nothing that can save it.

Go long anarchy and chaos; short soft landings and Goldilocks. But I hear Apple is rolling out iPad 2 soon, so economic nirvana must be just around the corner…

Once again, the media has it all wrong. Just the title says it all. There are 7,513 FDIC insured banks in the US. this writer is talking about a hand full of the larger ones. The 7,400 or so community banks are doing justr fine and this article has no bearing on them. please make the distinction in the furture.

[...] story of “uncertainty” is already a deeply embedded piece of lore. It’s also a great big lie — one that Barry Ritholtz helps to take apart, with hammer and tongs: There is a fundamental misunderstanding about the Wall Street bailouts amongst the public, and [...]

[...] story of “uncertainty” is already a deeply embedded piece of lore. It’s also a great big lie — one that Barry Ritholtz helps to take apart, with hammer and tongs: There is a fundamental misunderstanding about the Wall Street bailouts amongst the public, and [...]

“he did go swedish on the auto-industry” .. at a considerable expense to his own base .. agreed to by that owner base* .. but but but / why do the nice guys always turn cheek …. I’ll answer that / because we’re nice guys

“Capitalization: Remains too thin; leverage should be mandated back to the pre-2005 rule change of no more than 12 to 1; As we have learned, management does not keep adequate capital unless mandated to do so (sufficient capital reserves cuts into profits)”

Umm, when Goldman and MS converted to bank holding companies, they became subject to the Fed’s consolidated 12-to-1 leverage limit — no major dealer is subject to the higher 30-to-1 broker-dealer leverage limit that you always harp on anymore. They’re all BHCs now, so reversing the 2005 rule change on leverage would do practically nothing.

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